Dual threats to the bull market

Stocks have hovered at or near multi-year highs in recent months. In the case of the S&P 500 (^GSPC), the index has hit multiple new record highs in the first three months of the year. The bull market in stocks reached its five-year anniversary last week, but there is a pair of threats that could prevent the bull from making it to its sixth birthday: China’s slowing economic growth and the U.S. Federal Reserve.

The Fed: Under New Management

The more immediate threat is from the Federal Reserve. After years of low interest rates and easy money, Wall Street recoiled Wednesday at the mere possibility of a rise in interest rates any sooner than late next year. Traders are going through an adjustment period with a Federal Reserve under new management. New Chair Janet Yellen, perhaps unintentionally, offered up a more specific timeline for raising short-term interest rates in her press conference than the Fed did in its formal policy statement. In response to a reporter’s question about how long a gap there would be from the time the Fed completes its months-long wind-down of its bond-buying program to an increase in interest rates, Yellen said three fateful words: “around six months.” With the bond-buying program expected to be completely unwound by this fall, six months would mean an increase in rates could happen as soon as April of next year, sooner than the mid-to-late 2015 that many investors were expecting. Wall Street didn’t like that timeline and stocks and bonds sold off.

The China Syndrome

The other factor threatening to undermine the U.S. bull market is China’s softening economy. Goldman Sachs this week cut its 2014 and 2015 growth forecasts for China, citing recent weakness in trade and consumption data. Goldman now sees 7.3% growth for 2014, below China’s target of 7.5% growth. Compared with the United States’ 2.4% gross domestic product growth in the fourth quarter, 7.3% growth might sound pretty good. But consider that China’s economic growth peaked at 14% in 2007 and has declined steadily since.

Recent data from China’s National Bureau of Statistics showed slowing across the board, from manufacturing to retail and housing. In an effort to combat that slowdown, China last night announced it would accelerate construction projects and other measures intended to stabilize growth. The Chinese government is not alone in its concern. American companies operating in China are also worried about the country’s slowing growth and its impact on business. A new survey conducted by the American Chamber of Commerce in Beijing found executives increasingly concerned about rising labor costs and the availability of skilled workers.

Threats Near and Far

So which of these potential threats poses a greater risk to the bull run in the stock market? Yahoo Finance Editor-in-Chief Aaron Task says he can make a case for either one. “I think the Fed is probably more of a short-term risk to the market, but China is a very large, long-term risk to the global economy which of course would affect the markets and there is definitely some stuff happening there that people should be paying attention to.”

As the Chinese economy slows, China’s yuan is near a one-year low. Over the weekend, China doubled the currency’s trading range, allowing it to move up or down 2% from a reference rate that China’s Central Bank sets on a daily basis. The move is seen as an effort by Chinese officials to deter speculative capital investment by weakening its currency. “The Chinese authorities are very clearly trying to cool things off,” said Task. “We talk a lot about the Fed’s exit strategy, but the Chinese have a huge exit strategy of their own that they’re trying to navigate and it’s going to be very, very difficult for them to do it and if they make any kind of mistake, that could trigger some kind of debt crisis in China that will definitely have ramifications for the entire global economy.”

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